Can You Use a Personal Loan to Buy a House?
At a Glance
Most people must take out a loan to buy a home, and while a mortgage is the most common financing option, there are also some circumstances when someone might take out a personal loan for the purchase. While this is unusual and not typically recommended, there are some special cases when a personal loan would be a better option.
In this article, you’ll learn:
Buying a house with a personal loan
While you technically can use a personal loan to purchase a house, it’s not usually recommended due to the higher interest rates, lower loan amounts, and shorter repayment terms. Most of the time, you’ll want to secure a home loan, or mortgage, when buying a standard single-family home.
However, there are some circumstances when you could consider using a personal loan to buy a home, such as if you’re building or buying a smaller or tiny home. These houses cost much less than a single-family home so a personal loan could be a good choice, especially because some mortgage lenders choose not to finance a tiny or mobile home.
If you’re considering buying a tiny home, search for personal loan lenders that offer loans designed for these purchases. However, keep in mind you can’t usually use the home as collateral for the loan because it’s considered a cash offer, so you may have a higher interest rate.
Can you use a personal loan for a down payment?
When you purchase a standard single-family home using a typical mortgage, the lender will likely want between 3% and 20% as a down payment on the house (though the percentage varies depending on the lender and your situation). Depending on your finances you may be considering using a personal loan for that down payment, but that’s often not a good option.
When you apply for a mortgage, one factor the lender looks at is your debt-to-income ratio (DTI). If you take out a personal loan to pay the down payment, this increases your total debt and DTI. This could indicate you have problems managing your money properly and you may not be able to repay the mortgage, which can have a negative impact on your ability to get approved.
Ultimately, using a personal loan as a down payment can cause a variety of problems with the mortgage lender and for you, and can impact your overall ability to buy a house.
Personal loan vs. mortgage
There are several differences between a personal loan and a mortgage:
| Personal Loan | Mortgage | |
|---|---|---|
| Loan Type | Unsecured (no collateral) | Secured (home serves as collateral) |
| Cost | Higher risk, higher interest rates | Lower risk, lower interest rates |
| Loan Size | Typically no more $100,000 | Often no less than $100,000, up to millions |
| Loan Terms | Typically 3-5 years | 15- or 30-year terms |
| Closing Processes | Fast and simple approval and funding | Approval and funding can take days or weeks; closing fees are costly |
| Down Payments | None | 3% to 20% |
| Default Risk | If the loan isn’t repaid, it can be sent to collections. | If the loan isn’t repaid, the home can be foreclosed. |
Alternative ways to pay for a house
Instead of a personal loan, you may want to consider one of these alternatives to pay for a house:
- Mortgage: Traditional mortgages are offered by mortgage lenders and typically have lower interest rates because you’re using the house as collateral for the loan. Certain loans, such as those supported by Fannie Mae and Freddie Mac, will accept down payments of just 3%.
- Secondary loan programs: Some states offer a secondary loan to homeowners to help pay a down payment and closing costs. Check with your state to see what options it may have available.
- Government agency insured loans: There are some loans insured by a government agency, such as the Federal Housing Administration (FHA), Department of Veterans Affairs, and Department of Agriculture. These loans may or may not have a minimum down payment obligation.
- Home equity investments: If you already own a home, a home equity investment offers cash in exchange for a share in the future value of your home. Until you sell your house or the contract ends, you won’t have any debt, will owe no interest, and won’t have any monthly payments. Use these funds to finance a down payment or renovate your new house.
- Down payment grants: With a grant, you don’t need to repay the down payment, so these can make great financing options as opposed to loans. For example, the National Homebuyers Fund provides down payment grant assistant, up to 5% of the loan amount for low- and medium-income homebuyers. Any homeowner who qualifies can take advantage of this grant.
How buying a house with a personal loan can impact your credit score
Regardless which loan option you choose to use to buy a house, your credit score will be impacted. Even though your score isn’t the only factor considered by lenders, it can help determine your interest rates and if you qualify for figure loans.
When you apply for a personal loan, the lender will do a hard credit inquiry on your credit report. This will temporarily drop your credit score by several points, but this decrease is temporary.
Otherwise, your score is impacted by how you manage your monthly payments. If you make your payments on time each month, your credit score will improve. On the other hand, late or missed payments can seriously hurt your score. Stay on top of your payments by enrolling in auto-pay or setting a reminder on your phone or calendar.
Check your credit before applying for a loan
Whether applying for a mortgage or a personal loan to buy a home, it’s important to check your credit report first. Knowing your score can help you understand whether you’ll qualify for a loan, as well as what interest rate and terms you can expect.
The higher your credit score, the lower the interest rate and the better the terms you’ll qualify for.
There are several other ways you can check your credit range for free, including:
- AnnualCreditReport.com.
- MyFico.com.
- Some credit cards, financial institutions, banks, and loan statements provide credit scores on your statements.
To check directly through the credit bureaus:
- Create a myEquifax account to get six free Equifax credit reports each year.
- Experian offers a free report and FICO score, as well as credit monitoring and other benefits.
- VantageScore partners with a number of institutions to provide your score.
When you get your report, check it for any errors and address any inaccuracies before applying for a loan. If necessary, take time to improve your score so you can better your chances of getting approved and qualify for better rates and terms. Comparing different lenders will help you find the best loan for you.
FAQs
Check with individual lenders to understand their borrower qualifications, but in most cases you must meet credit score, history, income, and DTI qualifications.
Yes, you can buy a house even if you already have a loan. However, keep in mind that the more debt you have, the higher your DTI will be and this can make it more difficult to get approved for a mortgage or personal loan. It’s important to make your loan payments on time and keep your credit score high to qualify.
Yes, having a personal loan can affect a mortgage application. When you have a personal loan, your total debt is higher, as is your debt-to-income ratio. Having a high DTI can be an indication that you’re a higher risk to lenders, which may make it more difficult to qualify for a mortgage. However, making payments on time and managing your debt responsibly can lower your risk.
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